Thoughts on culture and events by author and illustrator Christopher R Taylor

Monday, June 20, 2011

THE CRUMBLING DAM

"Therefore we are still at risk of another crisis."

There's a book out called Reckless Endangerment by Gretchen Morgenson and Joshua Rosner that examines the financial crisis of 2008 that led to the banking collapse and the current recession/not-a-recession we are now enjoying. I haven't read this book but I have heard a lot of good things about it, and it seems to be opening eyes out there.

The book covers ground I and others have touched on here quite a bit, about how the Community Reinvestment Act, some changes in financial laws, and Fannie Mae/Freddie Mac combined to let banks lend to people who clearly cannot repay their loans, then sell these toxic mortgages to other banks as if they were valuable, all with the assurances that everyone would be okay because the government and Mae would cover their fannies. And to top it all off, regulators in the federal government were not looking into things too closely because to do so would cool off the housing boom which was making them look good.

This led eventually to banks just collapsing because they could not cover their debts and were carrying trash loans that never, ever would be repaid, which caused a run on banks, a lockdown on emptying accounts, the collapse of the housing bubble, and an overall economic slump worldwide which does not seem to be actually getting any better.

The book apparently looks more closely at various people specifically involved and who were most responsible for the damage that took place (which people who will never pay a price, by the way, such as Fannie Mae chief Johnson and Countrywide Mortgage CEO Angelo Mozillo). It also gives specific details about how things took place and names institutions and banks involved.

"Where in the world is the profit in that? If nobody can service the loan, if they can't make it back how do you make any money?" Good question. Here's how it happened. All of these mortgages which were required to be made were sitting there and, as individual mortgages, were worthless. So what happened, as simply as I can explain this, is that in the public sector -- and then there was a first instance of this in the private sector. I forget the name of the bank. The book mentions it. These mortgages were pooled. All of these disparate mortgages were pooled into one bundle, or a series of large bundles. You could say a security, a mortgage-backed security of say $130 million.

"Okay, but I still don't understand, Rush. If you got $130 million total mortgages, and nobody can pay 'em back. How do you make any money?" Well, you sell the mortgages to Fannie Mae, which is a government-sponsored enterprise. It's ostensibly a private sector enterprise with government ties. But the way it worked was this: When the government's involved, nobody loses money. The government's good for anything! If somebody blows up, the government bail 'em out. Fannie Mae will take care of it, and that's what happened. If they package these... From the standpoint of the bankers, they knew that they were sitting on worthless paper, all of these loans and mortgages.

So they tried to come up with ways to make it profitable. They package these bundles (these pools of mortgages), call it a security, and then they sell this to the unwitting. Just like the unwitting buy lemons and the unwitting buy all kinds of stupid stuff, you go out and you package these mortgages and you promise this giant income stream. You say, "By the way, it's backed by the federal government. No sweat here," and you pass it on to investors. Then each series of investors, at some point, realizes they've bought a bill of goods, worthless paper; and at each stage, the latest crew of investors, realizing they've been taken, tries to come up with a new way of monetizing these things so that they're worth something, and they can sell them to somebody else.

A whole economy built up around trading these bundles of worthless loans around back and forth because the government would back and protect you - Fannie Mae promised it would. And so they pushed for more crappy loans so they could get more to trade around and... well eventually it all fell apart like any scam does when people figure it out.

Incidentally a caller who works at a bank explained how the interest rules and banks giving loans make money without even getting a payment from the person they've loaned to and how that became a business all by its self too. Its a bit long and complicated, but he explains it well and its worth reading.

Here's the thing. Since World War 2, the nation has been wracked with repeated recessions and recoveries, stretching all the way back to the fifties where things started slowing down by the time Kennedy took office. Then after Kennedy there was an almost unbroken series of recessions through the 70s which the Reagan era ended, then another brief one as the Savings&Loan crisis and cold war end shifted things around, then another little one at the end of the 90s when the tax increases and Clinton era policies overtook the dot com boom.

When you look at history this way, it looks more like people have been stuffing fingers into cracks in the dam rather than a regular steady growth interrupted by occasional recessions.

And the problem is, the rules haven't really changed to fix matters any. The CRA is still in place, Fannie and Freddie are almost unchanged, the financial laws have changed little, the "too big to fail" companies are still too big to fail and ready to, and those toxic loans are still out there. All that's changed is that the federal government spent a trillion dollars to help big financial corporations gobble up little ones. The regulatory process is largely unchanged and there's no incentive to try harder to keep the process legal.

To me it looks an awful lot like that dam is crumbling and we're duct taping it in places with the hopes it holds long enough for our generation to run to the hill country.